Altria's Untapped $40 Billion Market: Marijuana in the U.S.

NEW YORK (TheStreet) -- Marlboro cigarette maker Altria (MO) controls 50.9% of the U.S. cigarette market. The company is still gaining market share; one year ago the company controlled 50.7% of the U.S. cigarette market. The U.S. cigarette industry is slowly declining as the negative health consequences of smoking become common knowledge.

Despite onerous taxes and advertising restrictions, selling cigarettes and other tobacco products in the U.S. is highly profitable. Altria has recorded about $24 billion in sales and $4.3 billion in profits over the last 12 months. Altria stock is up almost 40% over the last year, more than twice the gain of the S&P 500.

In the coming years, Altria may be able to tap into the growing U.S. marijuana market. The similarities between marijuana and tobacco are many. Both products are smoked and consumed repeatedly. Marijuana is not physically addictive like tobacco is, but marijuana is psychologically addictive. It also carries a cool vibe in many subsets of society that cigarettes no longer do. The primary reason Altria has not moved into the marijuana market is because marijuana is still illegal on a federal level in the U.S. Despite this, four states have legalized marijuana for both legal and recreational use (Alaska, Colorado, Oregon, Washington).

Size of the U.S. Marijuana Market

Colorado was the first state to legalize recreational marijuana sales. In August (the most recent month for which data are available), marijuana sales in Colorado, excluding black market sales, totaled $67.5 million. Recreational marijuana sales accounted for $34.1 million, while medical marijuana sales came in at $33.4 million. Colorado has a population of 5.26 million; total marijuana spending per capita in the state was $12.83.

The U.S. has a population of about 316 million. If the entire U.S. legalized marijuana and consumed it at a similar rate as the state of Colorado, the U.S. marijuana market would generate about $48.6 billion per year in sales.

A sizable chunk of Colorado's marijuana revenue was generated by tourists. This likely inflates marijuana sales numbers in the state. This would be partially offset if the entire U.S. legalized marijuana, as "pot tourists" from around the world would come to the U.S. Still, the effect is likely to be less on a percentage basis than what Colorado is experiencing.

The Houston Chronicle estimates the illegal marijuana market in the U.S. to be worth between $18 billion and $30 billion. This number is significantly less than the $48.6 billion estimate one can make by extrapolating Colorado's legal sales numbers. It is very likely that people will consume more marijuana when it is legal as compared to when it is illegal. The fear of being fined or going to jail combined with dealing with drug dealers makes a strong deterrent for illegal marijuana. If marijuana were completely legalized in the U.S., sales would be well in excess of even the high estimate of $30 billion in illegal marijuana use.

In summary, the marijuana market in the U.S. would generate between $30 billion and $48.6 billion per year in sales. A fair median estimate of the annual revenue generated by marijuana sales in the U.S. is about $40 billion. In comparison, the cigarette market generated about $66 billion in sales in the U.S. in 2013.

Timetable for Federal Legalization

If marijuana is legalized, the size of the market will be about two-thirds the size of the U.S. cigarette market. It is very likely the marijuana market in the U.S. would see positive growth while tobacco use continues to decline; marijuana revenue would eventually outstrip tobacco revenue. What is the probability that marijuana will be legalized in the U.S., and when will legalization occur?

Rep. Earl Blumenauer (D., Ore.) says federal legalization will occur in "less than five years." This is a very optimistic timetable for legalization, but it is possible. Public opinion on marijuana legalization has been gradually shifting toward legalization for years. Gallup Polls that asked the question "Do you think the use of marijuana should be made legal, or not?" have shown the following percentages in favor of legalization over the years:

1969: 12% in favor of legalization 1995: 25% in favor of legalization 2005: 36% in favor of legalization 2010: 46% in favor of legalization 2014: 51% in favor of legalization

Younger people are more likely to be in favor of legalizing marijuana than older people in the U.S. The numbers below show how much in favor of legalization people under 44 are, and how much more opposed to it people over 45 are:

Age 18 to 29: 60% in favor of legalization Age 30 to 44: 57% in favor of legalization Age 45 to 64: 41% in favor of legalization Age 65 and older: 37% in favor of legalization

If you believe the government reflects the will of the people, then marijuana will be made legal at the federal level. Over half the population believes marijuana should be legal. Younger voters are more in favor of legalization, and they will replace today's older voters over time.

The exact timing of legalization is difficult to gauge. Over the last decade, support for marijuana legalization has swelled. As more states adopt promarijuana legislation and generate significant tax revenue, it is likely that both government perception and public perception will continue to trend toward legalization. Five years to federal legalization is an optimistic view and likely has a 25% chance of occurring.

A 10-year window is significantly more likely. Ten years ago, only 36% of people were in favor of legalization. In 10 more years, 60% or even 65% -- a solid majority -- of the population will be in favor of legalization. Let's estimate a 50% likelihood of legalization occurring somewhere between 5 and 10 years from now.

Lastly, there is about a 25% chance of legalization occurring in 10 to 15 years. This longer time frame reflects a more pessimistic view (from the viewpoint of the marijuana industry). A longer road to legalization will occur if unanticipated setbacks such as strong lobbying against marijuana or public backlash occur.

A probability-weighted legalization date is about 7.5 years from now. This is a rough estimate only, but it takes into consideration current legalization trends and the probability of unexpected events.

Altria's Marijuana Potential

Altria has significant potential in the marijuana industry, if legalization occurs. It is very unlikely that people will "grow their own" marijuana or support higher-priced boutique dealers en masse when legalization occurs. Altria and other large tobacco corporations will have strong competitive advantages over smaller businesses in distribution, marketing, brand strength and economies of scale. There will undoubtedly be a market for the "DIY" marijuana enthusiast as well as the boutique marijuana grower, but the lion's share of the market will belong to businesses with the strongest competitive advantages.

If Altria captures the same market share of about 50% in the marijuana industry as it has in the cigarette industry, the company will generate an extra $20 billion in revenue per year. The company currently generates $24 billion per year in revenue. If Altria can capitalize on the marijuana market as well as it has on cigarettes, the company will nearly double in size. Even capturing just 10% of the marijuana market would boost revenue by about 17%, a strong surge in growth for a company operating in the stagnant tobacco industry.

The table below shows the present value of the marijuana industry to Altria at different levels of market share over several assumptions. The assumptions are:

Marijuana will be legalized in 7.5 years.

The marijuana market will generate $40 billion per year in revenue.

A 10% discount rate is used.

A 3% marijuana industry growth rate is used.

Altria maintains a profit margin of 18% on marijuana products.

Altria's Market Share of Marijuana Industry

Present Value of Future Cash Flows

10% share

$5.03 billion

20% share

$10.07 billion

30% share

$15.10 billion

40% share

$20.13 billion

50% share

$25.16 billion

Final Thoughts

Altria has a current market cap of about $99 billion. Somewhere between 5% and 25% of the company's current value can be accounted for from potential cash flows from the marijuana industry. The potential cash flows from the marijuana industry are material to investors in Altria. Despite strong potential, cash flows from the marijuana industry are likely several years away.

Fortunately, investors get "paid to wait" because Altria has a dividend yield of more than 4%. In addition, the stock has a low price standard deviation of just 20% and has managed to grow revenue per share at about 5% a year (thanks to strong share repurchases) over the last five years. As a result of its decent growth, strong yield, and low price volatility, Altria is a top 30 stock based on The 8 Rules of Dividend Investing. Despite declines in the tobacco industry, Altria has solid long-term growth potential due to the enormous potential of the marijuana market.

At the time of publication, the author had no positions in any of the stocks mentioned, although positions can change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates ALTRIA GROUP INC as a Buy with a ratings score of B+. TheStreet Ratings Team has this to say about their recommendation:

"We rate ALTRIA GROUP INC (MO) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its growth in earnings per share, increase in net income, solid stock price performance, expanding profit margins and notable return on equity. We feel these strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated."